Wednesday, February 14, 2007

• Net of one-timers the EPS reported was generally in-line - but growth was certainly supported by better than expected investment gains and excellent credit experience. Manulife reported Q4/06 EPS of $0.70, with about $0.05 per share in one-timers ($0.04 tax related and $0.01 due to a net recovery on credit in the quarter, as confirmed by management). Net of the one-timers the EPS was $0.65, $0.01 above our estimate and in-line with consensus. Excluding the one-timers EPS growth was 13% YOY.

• Once again, exceptional growth in the Fixed Products segment continues to drive growth - as this returns to average levels suggested by management, EPS growth should decelerate. The company once again noted that earnings in the U.S. Fixed products segment (primarily spread-based business, about 1/3 of the company's U.S. earnings and about 15% of the company's bottom line), were unusually strong, and that, consistent with prior comments, it does not expect the segment's results to continue to contribute to earnings at this current level. Earnings in this segment were up 69% in Q4/06, and were up 54% in 2006. With earnings of US$75 million per quarter indicated by management to be the expected average, well below the US$132 million earned in Q4/06, and well below the US$140 million average over the last three quarters, we certainly expect earnings growth in the U.S. division to decelerate. Assuming the Q4/06 earnings in the segment were the US$75 million suggested as the average by management, we put EPS growth at 9%, and 12% excluding f/x. See Exhibit 1 below for an outline of the growth excluding the tax gains, credit recoveries and exceptional results in the Fixed products segment.

• We're reducing EPS by $0.03 in 2007 and 2008 to reflect this "guidance" with respect to the Fixed Products underlying earnings power.

• Top-line growth in all-important U.S. market was weaker than we expected. After rapidly gaining market share in the all-important U.S. market in 2005 and through the first half of 2006, we were of the belief that MFC would maintain its share through the end of 2006 and throughout 2007. Now we're not so sure. U.S. variable annuity sales continue to slide, down 9% in Q4/06, after declining 8% in Q3/06. Albeit the comparison is off a strong second half of 2005, the sales growth we're seeing from other U.S. variable annuity players in the quarter (Hartford up 26%, Prudential up 34%, Lincoln up 22%, Ameriprise up 54%, Sun Life up 52%, Nationwide up 60%) suggests to us the company may be losing share, despite efforts in Q4/06 to rejuvenate sales with new enhanced riders to its products. Management suggests that we're in an intensely competitive stature in the market, and in order to gain share the company will need to introduce new product. We remain cautious, but look to the addition of new distribution arrangements with Morgan Stanley (wirehouse channel) and JP Morgan Chase (bank channel) as possible ways the company may be able to stop its current decline. Individual insurance sales were also down (10% YOY). Given the company's high ranking market position in individual insurance, we would expect sales in this segment to remain in the low single digit level at best, in-line with the growth in market.

• Japan top-line growth slower than expected. In Japan, the company indicated that, after the new variable annuity product was launched mid-November 2006, the ramp-up in new variable annuity sales has been slower than originally expected (sales down 64% YOY in constant currency), due to increasing competition. With Hartford (over twice the market share of Manulife in Japan variable annuity sales) recently releasing a new product in early 2007, we expect the level of competition in this market will remain intense. In addition, individual insurance sales continue to decline, down 17%, after declining 22% in Q3/06, with 2006 sales levels down 22%. While earnings growth in Japan will benefit to some extent from growth in variable annuity assets, favourable markets, and a much improved investment climate, we believe a catalyst for the division could be a potential deal with Bank of Tokyo Mitsubishi (BOTM) to distribute individual insurance products via the bank's branches when the industry further deregulates at the end of 2007. We continue to watch this carefully, but remain somewhat sceptical as to whether in fact this will happen (competition in Japan continues to intensify) and how it might translate into significant sales and earnings growth.

• Premium multiple to the group is likely to continue to decline to levels closer to long term average, as top-line growth slows and earnings momentum decelerates. Manulife's forward P/E premium to the group is coming down, and we believe it is more likely to decline a little further, closer to its long term average. The premium was above 10% in May 2006, is now 5%, but is still above its 2% long term average. We believe any expansion in Manulife's multiple versus the group is highly contingent on its ability to gain market share, as opposed to merely maintaining share, or worse, lose share. We believe any further growth in the company's premium relative to the group is less likely, in fact the opposite is more likely, as the rapid gains in market share the company made in the 12 months leading up to June 30, 2006 will almost certainly be not repeated in the next 12-18 months. Add to this the expected earnings deceleration propelled by the Fixed products segment (a segment we believe the company somewhat reluctantly accepted from John Hancock and has looked to de-emphasize), and we believe the company's EPS growth, expected to be 12% annually through 2008, will certainly be more in-line with the others. We have an EPS CAGR for GWO at 14% through 2008, with 12% for Sun Life.

• European windstorm Kyrill adds a small element of uncertainty in near term. The company indicated that if losses for European windstorm Kyrill were in excess of US$10 billion the company could face a loss up to $130 million or about $0.08 per share, and if losses were slightly below US$10 billion the loss would be around $0.04 per share. From what we gather, early estimates indicate losses from Kyrill could be as high as US$10 billion. • Canadian division was a bright spot in the quarter - but it's likely not a catalyst. With individual insurance sales up 17%, individual wealth management sales up 16% helped by the introduction of the new GMWB product (which helped individual segregated fund sales increase 36%), the Canadian division had a strong quarter, with earnings up 13%, excluding the impact of tax gains. However the Canadian division, in our opinion, is not a catalyst to the story (less than one-quarter of the bottom line, a mature market that despite being an oligopoly does not behave as one, organically remains challenged to grow earnings significantly above 10%).

• Focus likely to continue to be on organic growth with no significant increase in buybacks or dividend payout ratio. When asked about acquisitions CEO Dominic D'Alessandro suggested that values are pretty high, and, with excellent credit and buoyant equity markets, there is no compulsion for others to sell. We get the impression this company prefers to wait for "blood in the streets", and, not seeing that now, will focus on its primary goal over the last several years, that of growing the business organically. We also see no immediate indication of a significant increase in share buybacks (run-rate is about 3% of outstanding shares annually), nor an increase in the payout ratio (currently 29% of 2007E EPS, target is 25%-35%).

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Financial Post, Jonathan Ratner, 14 February 2007

Investors continue to flock to Manulife Financial Corp.. And why not? The company just unveiled fourth quarter earnings that topped $1-billion for the first time, rising 21% from a year earlier.

While the stock is just shy of its 52-week high, analysts remain somewhat mixed on where shares in Canada’s largest life insurance company may be heading.

He has a “top pick” rating on the stock, but notes that market reaction could be tempered by what he calls “a lacklustre recovery” in Japanese variable annuity sales – products that typically offer a range of investment options, under which the insurer agrees to make periodic payments to the holder throughout their lifetime.

Manulife’s earnings were up 13% quarter-over-quarter, while the value of its new business rose sharply, 25% on an annual basis, “which we believe is attributable to strong growth in both the insurance and wealth management businesses,” Mr. Goldberg said in a research note, adding that new business should be a focus when analyzing life insurance companies.

UBS analyst Jason Bilodeau is also optimistic about Manulife shares, hiking his price target to $46 from $44, while maintaining his “buy” rating following the results.

While variable annuity and life insurance sales trends may continue to change course, what matters most is Manulife’s position as a top industry operator in terms of delivering profitable sales growth through the cycle, Mr. Bilodeau said in a research note.

“Competition remains intense and the market backdrop is unlikely to get much better, but we look for product innovation to rejuvenate Manulife’s sales trends in 2007,” he said.

Merrill Lynch’s Andre-Philippe Hardy has a “neutral” rating on Manulife shares, noting that his valuation on the company is the highest among its peers.

He also pointed to management’s focus on reinvigorating sales growth through an array of new products set to be launched.

The financial services company earned C$1.11 billion or 70 Canadian cents a share in the fourth quarter, up from C$900 million or 56 Canadian cents a year earlier. The latest period is the first quarter in which Manulife has topped C$1 billion in net income.

"I am very pleased with our performance in 2006 and look forward to our progress in the years ahead," Manulife Chief Executive Dominic D'Alessandro said on a conference call.

Manulife sold more insurance policies in Canada in the fourth quarter of 2006, helping offset a slump in the U.S. and Japan. Earnings were also given a boost by the strong performance of its U.S. Wealth Management unit, and analysts said a tax change added between 2 Canadian cents and 4 Canadian cents to the bottom line.

It was a good quarter "with predictable strength in U.S. Wealth Management and Canada" helped by the tax gains, and offset by weaker results in Asian and U.S. insurance, said John Reucassel of BMO Capital Markets. "Asset quality and capital ratios remain quite strong."

BMO Capital Markets has an investment-banking relationship with the company, but it wasn't immediately clear if the analyst holds shares.

Return on common shareholders' equity improved to 18.0% from 15.5%, while revenue rose to C$9.19 billion from C$8.40 billion last year.

Total funds under management were C$414 billion at the end of the year, up 11% from C$371.5 billion.

However, premiums and deposits fell 2% to C$15.8 billion from C$16.2 billion after the company suspended variable annuity sales in Japan.

As with its rival, Sun Life Financial Inc., Manulife saw earnings at its U.S. insurance division fall in the period. Net income from that business unit was C$168 million, down 6% from C$178 million a year earlier, primarily due to unfavorable claims experience at John Hancock Long Term Care. Mitigating that impact were better margins and fewer mortality claims at John Hancock Life.

On the other hand, premiums and deposits in the U.S. grew by 7% on strong sales, and higher in-force business growth at John Hancock Long Term Care.

As well, net income at the U.S. Wealth Management division rose 39% to C$300 million from C$216 million a year earlier as investment income soared on strong equity markets. On a U$basis, earnings increased 43%.

UBS said the U.S. wealth-management division was "the key driver" in the fourth quarter on the strength in equity markets. However, Scotia Capital said in a note that the 7% growth in premiums and deposits was "well below what we're seeing from other U.S. players."

Scotia doesn't have an investment-banking relationship with the company but the analyst owns the stock. UBS makes a market in the securities.

The Asia and Japan division also underperformed, with net income slipping 16% to C$191 million from C$228 million a year earlier. Excluding the impact on actuarial liabilities in 2005 from reducing equity exposure in Japan's Daihyaku block, earnings rose 8%.

The decrease was partly caused by a decline in variable annuity sales due to the temporary suspension of a product in Japan, pending clarification of its tax treatment. A replacement for the suspended product was launched in November.

Funds under management, however, grew by C$6.3 billion to C$38.0 billion from C$31.7 billion a year earlier.

It was a much better story in Canada, where net income rose 24% to C$247 million from C$199 million, driven in part by changes to Ontario tax rules. Excluding the C$20 million boost to earnings from that change, income rose 14% on growth in bank assets, segregated funds, and the rising stock markets. Poor claims experience offset some of the gains.

Premiums and deposits for the quarter were C$3.5 billion, up 4% from C$3.3 billion a year earlier.

However, Ken Zerbe at Morgan Stanley said that excluding the tax benefit, " Canadian earnings would have fallen well below expectations on the back of unfavorable claims in its Group Benefits business."

In fact, he said, the upside in Manulife's earnings "came almost entirely from its corporate segment", which reported C$40 million in favorable tax items, " most of which will not recur and should be excluded from its core run rate."

Morgan Stanley has an investment-banking relationship with Manulife, but the analyst doesn't own shares.

After Manulife launched a new guaranteed minimum withdrawal product last year, segregated fund deposits in its Individual Wealth Management division rose 36%. "The product launch looks to be off to a great start," UBS said.

On the other hand, mutual-fund deposits continue to disappoint and Manulife said it launched four new funds in the third quarter of 2006 to try to increase its competitive position. It plans further enhancements.

The property and casualty reinsurance division, which lost C$29 million last year due to Hurricane Wilma, reported net income of C$68 million. Premiums were C$307 million, up from C$249 million in the fourth quarter of 2005.

Michael Goldberg at Desjardins Securities, who had predicted Manulife would earn 69 Canadian cents a share in the quarter, noted in an earnings preview that strong equity markets would help boost life insurance company earnings in the fourth quarter.